As you know by now, the budget process deals with all five levels of the BPI project, but in this chapter we will concentrate primarily on three of them: research, plan, and design. It is important to research the current processes and document the en- tire process so that you can find the improvement opportunities in the budgeting process. After researching the processes, you need to make a detailed plan that de- scribes each and every activity and that lists the resources involved. Finally, you must design the new budget process, to include the new or streamlined processes (see Exhibit 8.1).
Annual budgeting is a vital activity that is mandatory for most managers. Hence, managers are always looking toward the future, meaning that planning is a key com- ponent of any management work. Simply put, the budget is a quantitative and quali- tative illustration of the plans for the coming year. The budget is the primary tool that can give authenticity to an organization’s objectives, strategies, priorities, and plans.
Resources are essential for a company to achieve its goals and so they must be planned for as well. Similarly, goals take on meaning only when they are reflected in the budget.
The first step in budgeting is to determine the right modelto use for your com- pany. In the simplest form, a model is a relationship among variables articulated in equation form. Models are designed with knowledge, information, and assumptions about elements of a variable. Individuals who do their own personal budgets, always use a model, albeit a simpler one. For example, if you paid, on average, $100 a month for gasoline last year, but you assume that you will drive 50 percent more this year, then you will budget $150 a month for gasoline in the next year. In essence, you would design a growth curve modelon certain accounts, or use a software program such as Quicken to help you. Companies also use budgeting software to help develop their models.
A model can mean different things to different people. A model can be a data- base that includes budget forms and reports, or it can be a link among many Excel worksheets. In this chapter, we cover the issues that will enable you to make the right choice of a budgeting model by discussing a company’s values, risks it faces, and its strengths and weaknesses.
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EXHIBIT 8.1Improving the Budget Process
Company ValuesEmployee
RevenueChart of Accounts
Customer NeedsResearch
Improve Budget Process Design Plan Reporting and AnalysisAccountabilityData EntryTimeline Enablers Best PracticesTechnologyStrategic TWorkflowHuman Resources
Objectives Assumptions
Drivers
Top-Down/Bottom-Up Best Practices
Users
Special Consider
Costs Capital Cash Flow and Balance Sheet
Risks Gaps
Strengths and Weaknesses Training
COMPANY VALUES
Company values are typically written down and are frequently changed, but do they really define the values of a company? Recently, such “value statements” have be- come very generic at organizations, making them virtually meaningless. Thomas A.
Stewart, in his article “Reassessing the Corporate Value Statement”1, describes a practice among MBA teachers to ask students to retrieve the value statements from their organizations and bring them to class. The teacher has each value statement typed in the same font and then displays printed copies on a wall. Most students have a very difficult time trying to identify their company’s statement. Most value state- ments use all or some of these words: integrity, respect, teamwork, excellence, and communication. These should be staples of all organizations and should not need to be referenced by a company as “values.”
Ideally, corporate values should help employees do their jobs more effectively.
Values should suggest priorities that guide employees to do the right thing and to feel good about themselves and their company. Does your organization cite integrity as a value, but, in practice actually demonstrates very little integrity in its day-to-day operation of business? Actions are what really define a company’s values, just as your actions define your individual values. What you say has little influence over people if you behave in a totally different manner. It works the same for companies. Enron is an example of a company that did not follow its value statement:2
Our values:
Communication—We have an obligation to communicate. Here, we take the time to talk with one another and to listen. We believe that information is meant to move and that information moves people.
Respect—We treat others as we would like to be treated our- selves. We do not tolerate abusive or disrespectful treatment.
Integrity—We work with customers and prospects openly, honestly, and sincerely. When we say we will do something, we do it; when we say we cannot or will not do something, then we won’t.
Excellence—We are satisfied with nothing less than the very best in everything we do. We will continue to raise the bar for everyone.
The great fun here will be for all of us to discover just how good we can really be.
Ask yourself: Why are values important to you? Probably your answer depends on how you are associated with the company. You may be an investor, a customer, a supplier, or an employee of a certain company, in which case it is entirely up to you whether you want to be associated with a company that has poor values. For exam- ple, would you want your name associated with a company like Enron? Now ask yourself how values can improve your budget process. Your company’s value state- ment alone will not help; but if the company practices what it preaches, then it can smooth the process.
An example of a value to improve the process is communication. Goals should be communicated regularly to all employees. And communication should be a two-way
street: employees should be able to speak openly with the management; likewise, management should be able to speak openly with the executives of the company.
Another value would be to give employees responsibilityfor their job and their de- cisions. Employees typically do a better job if they are challenged and feel that their work is respected.
RISKS
We live with risk every day, both in our working and personal environments. For example, you must manage the risk of investing your money, whether you take risks in the stock market or place your money in a certificate of deposit. Typically, a com- pany or an individual will increase risk to generate a larger return. The stock market presents a greater risk than a certificate of deposit, but you should anticipate a larger return over time to compensate for the extra risk.
Companies must make decisions on a daily basis that may have profound risks for the future of the company. There are risks in emerging industries, such as the presence of market and technological uncertainties, difficulties of forecasting and budgeting, and the need for large investments. Two indicators of the risk of emerging industries are the high cost of capital and the frequency of corporate failure. Therefore, it is imperative that management effectively manages risk in order to succeed. Managing risk alone does not guarantee success; but it will be very difficult to succeed without managing risk. There are four different types of risk that management must consider:
1. Economic risk. These risks, such as fluctuations in business activity, changes in interest rate, and purchasing power, are inherent to a company’s operating en- vironment. These are typically impossible for an organization to control, but managers must be aware of these when making business decisions.
2. Business risk. This is the uncertainty regarding a company’s capability to earn a reasonable return on its investment in light of the revenue and cost factors, which include competition, product blend, and management aptitude. This risk is based on the strength and/or weakness of the individuals running your organization.
3. Financial risk. Financial risk refers to the capital structure of the organization and its capability to meet its financial demands, such as paying off claims against it. If a company cannot meet its financial obligations, then there will be many competitors looking to take advantage. Currently, for example, Adelphia Cable has filed bankruptcy and the satellite companies in Southern California have started an ad campaign that talks of Adelphia Cable’s demise.
4. Accounting risk. This is inherent in the submission and choice of the account- ing methods, which include management leeway in controlling the production of the accounting process. Recently, this has become more of a risk since many organizations are using the illegal accounting methods that have brought down many organizations, such as Enron and Global Crossings.
The following are some of the ways that companies can cope with risk:
• Cooperate with lead users. A lead useris typically the industry leader or the company that has developed new technology. Cooperating is most important
during the early phases of industry development. It is vital to monitor and re- spond to market trends and customer necessities, to avoid mistakes in technology and performance. Companies should try to identify users whose present needs will become general market trends in the future and to develop close ties with such customers, and doing so can be essential to maintaining technological progressiveness.
• Limit risk exposure. Organizations should try to adopt investment procedures to minimize their exposure to risk. Many companies do not have the cash flow to overcome the downturns in the market. A good example are the dot-com com- panies: They spent money like there was no tomorrow, then most went out of business when the economy slowed. A way to limit risk is to partner with another company or to create an alliance with other companies when developing new products. This has become more commonplace in the twenty-first century.
• Be flexible. Flexibility is critical to a company’s long-term success and survival.
Market changes and technological advances are becoming more difficult to fore- cast; therefore, it is essential that organizations be able to quickly and effectively respond to these changes.
• Assign capital risk to each business unit. This will enable the company to see which departments/entities are increasing the shareholders’ wealth and which are not. You may use a measurement called Economic Value Added (EVA) to determine the true economic profit of a department. It is calculated by taking the operating profit and subtracting an appropriate charge for the opportunity cost of capital invested in a department.
• Analyze competitors/economy. Companies should have competitor analysis available at all times, and it should be regularly updated. It is good business practice to always be aware of any changes in your competitors’ marketing plans, products, or management that may affect your business. It also make good busi- ness sense to keep an eye on the future of the economy and to forecast the ef- fects that the economy might have on your business.
• Develop a corporate strategy. A strategy that is communicated and built upon the management’s strength will be beneficial to a company both in the short- and the long-term. This topic is covered later in this chapter.
STRENGTHS AND WEAKNESSES
It is very common to find companies that have difficulty determining their strengths and weaknesses. Companies are often changing their dynamics through acquisitions, new employees, new products, or new technologies. These changes can be better managed if the leaders are aware of the company’s strengths and weaknesses before changing the dynamics of its organization.
Companies can use a checklist, or a consultant, to determine their strengths and weaknesses periodically and to attribute a level of importance to each category. The question that companies need to answer is: should it limit itself to those opportuni- ties for which it has the required strengths or consider better opportunities for which
it might need to acquire or develop additional strengths? Microsoft is a great example of this in regard to the X-Box. The company’s strengths were in software, but it also had tremendous strengths in marketing, so it acquired a company that was creating videogame software and designed a videogame for the home. Though sales did not meet expectations, Microsoft nevertheless attempted to use a current strength on a product for which it had no experience. The point is, your organization does not have to stay away from its weaknesses or try to improve them, but it is important to know that weaknesses can be turned into strengths. If a company is always trying to fix its weaknesses, then it may spend all of its time doing this rather than capitalizing on its strengths.
There are two different types of charts that your organization can use to help de- termine its strengths and weaknesses. The first one includes two different types of matrixes: an opportunity matrixand a threat matrix. The opportunities are classified according to their attractiveness and their probability of success. The company’s prob- ability of success is revealed by its market and its competition. The most success- ful company will be able to create customer loyalty and maintain it. Any product or service that is in box 1 shows that the company should definitely go after these prospects. Companies should stay away from opportunities in box 4, and instead follow the prospects in the other two boxes (see Exhibit 8.2).
EXHIBIT 8.2 Positioning Tools
CHECKLIST FOR STRENGTH/WEAKNESS ANALYSIS Marketing Performance Importance 1. Company Reputation _______ _______
2. Market Share _______ _______
3. Product/Service Quality _______ _______
4. Pricing Effectiveness _______ _______
5. Distribution Effectiveness _______ _______
6. Promotion Effectiveness _______ _______
7. Sales Force Effectiveness _______ _______
8. Global Coverage _______ _______
Finance
1. Cost of Capital _______ _______
2. Cash Flow/Liquidity _______ _______
3. Financial Stability _______ _______
Manufacturing
1. Facilities _______ _______
2. Economies of Scale _______ _______
3. Capacity _______ _______
4. Technical Skill _______ _______
Organization
1. Leadership _______ _______
2. Flexible _______ _______
3. Employees _______ _______
High Low
High 1 2
Low 3 4
OPPORTUNITY MATRIX Success Probability
Attractiveness
High Low
High 1 2
Low 3 4
THREAT MATRIX Probability of
Occurrence
Seriousness
Threats are classified by the probability of occurrence and in the seriousness.
Companies will need to take immediate action for threats in box 1, ignore those in box 4, and evaluate the other types of threats. In conclusion, an ideal business will have many high opportunities and few major threats. A mature company will have few op- portunities and few threats. A company with few opportunities and many threats will not last long, while a speculative company will be high in both categories.
The checklist is a way for companies to grade themselves on a scale in many different categories. The grading scale can be 5 for a major strength, 4 for a minor strength, 3 for neutral, 2 for a minor weakness, and a 1 for a major weakness. For importance, the scale might be 3 for high, 2 for medium, and 1 for low. You should be on the lookout for weaknesses that have a high level of importance so that it can be improved upon. Honeywell, for example, has a great program that is designed to improve the weaknesses in intercompany communications. Each department is re- quired to rate its own strengths and weaknesses and those of the other departments with which it interacts. This is a proactive step by Honeywell, one that enables it to determine each department’s weaknesses.
ENDNOTES
1. Thomas A. Stewart, “Reassessing the Corporate Values Statement,” Business 2.0 (March 13, 2002), access at http://www.business2.com/articles/web/0,1653, 38800,00.html.
2. Shari Caudron, “Strength in Numbers, Part Two,” Controller Magazine(March 1996): 31.
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